Paul Romer argues for “charter cities”

Paul Romer argues for a new method to alleviate poverty. It is based on stimulating economic growth (thus reducing poverty overall) by developing “charter cities”, which is a city-scale administrative region governed by a coalition of nations and has a rules-based system that will attract investors and people who want to live in a stable, secure and progressive society. It is like creating commerce hotspots and stable (rules-based) cities like like Hong Kong (administered by British until 1997) or several key costal hot spots like in China. He argues for creating new cities where people can go to escape from bad rules and governance and opt in to new and better ones.

From TED blog:

He shows a picture from NASA of the Earth at night, clearly showing the electric lights of cities and town. He points out that North Korea looks like a black hole compared to neighbors, and reminds us that North Korea and South Korea began identically but made choices that led to very divergent paths. He points to the Caribbean. He shows how dark Haiti is compared to the Dominican Republic and that they're both dark compared to Puerto Rico. Haiti warns us that rules can also be bad when governments are weak, as opposed to the strong government of North Korea.

Romer asserts that we must preserve choices for people and operate on the right scale. A village is too small and a nation too big. Cities give you the right balance. The proposal is he conceives of is a charter city with investors to build infrastructure, firms to hire people and families who will raise children there. All he wants is some good rules, uninhabited land and choices for leaders, which he thinks should translate to partnerships between nations.

I wonder how the issues related to sovereignty and occupation would be resolved with this new model. Also, if implemented, for how long will this model, which seems more or less like an export-based or trading hub model revolving around SEZs last? Everything is hinged upon having a political will and consensus, which by the way are the most difficult things to have in most of the developing countries. If it were so easy, then aid would have worked better, leaders would have been more responsive to their voters than to donors, governance would have improved, the probability of conflicts and coups would have decreased drastically, market-friendly policies would have actually been implemented in reality, and a democratic, people-centered process have flourished. There would be no need for any special cities with special facilities and characteristics.

More about Romer and his new initiative here.

Sticky inflation and policy options for Nepal

In my latest op-ed, I discuss why general price level is so sticky in Nepal and why inflation rate is not fully consistent with the growth rate in money supply (M2). I argue that higher inflation rate in the Nepalese economy is not due to demand side factors but because of supply side factors, mainly supply bottlenecks. There is little the central bank can do without severely disrupting economic activity, which has been at a very low level. In order to tame down sticky inflation at high levels, the government has to use political, regulatory, and diplomatic means at its disposal.

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Sticky inflation & policy options

The inflation rate right now is around 13 percent. The government plans to bring it down to 7 percent this fiscal year. With an aim to attain this target, the central bank also announced monetary policy immediately after the finance minister presented this year’s fiscal budget. It should be noted that the planned policies of the government (and the central bank) to bring inflation rate down by about five percentage points in a year are not fully clear and so far have failed to convince investors that they have necessary tools and plans to meet the target. The factors that are causing unabated rise in general price level are supply side and there is very little the central bank can do given the nature and causes of rising general price level, which appear as sticky as wages are.

Let’s recall significant inflation peaks and troughs and associated money supply in the past. In the last five decades, the highest inflation rate—measured by consumer price index (CPI)—of 19.8 percent was recorded in 1974. In 1986 and 1992, the inflation rate was 18.9 percent and 17.1 percent respectively. The growth rate of M2, a broad measure of money supply and a key economic indicator used to forecast inflation, was 17.1 percent in 1974, 19.4 percent in 1986 and 20.7 percent in 1992. The lowest inflation rate of negative 3.1 percent was recorded in 1976 with growth of M2 approximately 28.9 percent. In the past eight years, the highest inflation rate of 7.6 percent was recorded in 2006 with a growth of M2 equal to 14.7 percent. Meanwhile, the lowest inflation rate in the past eight years was 2.5 percent in 2000 with a growth of M2 equal to 18.9 percent. Nepal has been facing inflationary pressure since the third quarter of FY 2007/08. The average annual percentage growth in inflation rate between 2000 and 2007 was 5 percent. It was 7.7 percent in 2007 with growth rate of M2 equal to 18.6 percent.

Note that in an economy like ours where economic and financial institutions are just starting to take shape coupled with substantial lags in policy implementation, it is not surprising that the trend in inflation rate is not fully consistent with growth in money supply. This means the factors causing rising price level are outside the boundary of traditional monetary instruments at the disposal of the central bank. The inflation rate of approximately 13 percent at present is the highest in this decade and, importantly, out of sync with monetary and exchange rate policies. What raises eyebrows is that the price level in Nepal is not consistent with the one prevailing in the Indian economy. The price level in Nepal is supposed to move in tandem with that of the Indian economy mainly because of close integration of the two economies, fixed exchange rate between Indian and Nepali currency and easy currency convertibility in the Nepali market.

In the previous years, the price level was not sticky as it is right now. The high inflation rate in 1974 was caused by global fuel crisis in the 70s but it quickly plunged down as fuel prices stabilized. Similarly, the rise in price level in 1992 was primarily due to a surge in investment following liberalization of the economy under a new industrial policy. Again, price level quickly fell down in the following years. This time, the story is different. Initially, domestic prices shot up due to high global food, fuel and commodity prices and an intensification of domestic supply bottlenecks in the beginning of 2008. Despite decline in global food, fuel and commodity prices, the general price level in Nepal is still on the rise. What could be the cause(s)?

In the past five years, gross consumption on average has been 90 percent of GDP and it has not changed radically. So, its pressure on general price level is more or less the same in the past several years. Similarly, investment level in the economy is also not increasing as alarmingly as price level has. Furthermore, the changes in imports and exports are also not as dramatic as the rise in price level. This means that the continuing rise in prices cannot be fully explained by demand side factors.

It appears very likely the main driving force behind rising price level is supply bottlenecks. Some studies reported in the media indicate that hoarding and black marketeering is contributing 30 percent to the rise in price level. Similarly, stockists and wholesalers are contributing 20 percent, bandas and strikes 10 percent while export hurdles from the Indian side are contributing 40 percent. All of these factors have created supply shock in the domestic economy, causing prices to spiral up quickly and remain sticky at a high level. For instance, transport obstructions and strikes hinder supply of essential goods and commodities, leading to short-term shortage and quick rise in prices. Note that between January and July 2009 alone, there were 612 transport obstructions and closures in different parts of the country.

It is ironic that despite being a monetary variable, the solution to rising inflation rate in the Nepali economy right now is beyond the realm of monetary instruments at the disposal of NRB. The central bank has already done what it could do (the NRB kept cash reserve ratio (CRR) and bank rate unchanged at 5.5 percent and 6.5 percent respectively) without severely disrupting economic activity. Even if it engages in aggressive open market operations, the supply side constraints won’t be relaxed easily.

The spiraling price level has to be checked and dragged down through regulatory, political and diplomatic means. First, it is a collective responsibility of all the political parties to forge a consensus in discouraging road blockades, the most popular form of protest against whoever is governing the country. This would help smoothen supply and control short-term price volatility in local markets. Second, the government has to aggressively use its regulatory power to raid shops and castigate wholesalers and retailers that are deliberately holding back inventories and artificially jacking up prices. It could also engage in rationing and reducing import taxes on essential goods that command more weight in the basket of goods and services consumed in the economy. Third, the government has to pursue diplomatic means to convince the Indian government not to ban exports of or impose high export tax on essential items that are widely used in Nepal. Prime Minister Madhav Kumar Nepal should raise this issue with his Indian counterpart during his trip to India in two weeks.

The rising price level is eroding purchasing power of people and is making them poorer in real terms. To restore investor confidence in the economy, controlling rising inflation rate is essential. And, since there is little the monetary authorities could do, it is up to the coalition government and the opposition parties to find ways to control rising prices because the causes clearly are supply side and quick solutions lie in how well our politicians and policymakers use political, regulatory and diplomatic means at their disposal.

Financial crisis, globalization and South Asia

Here are the main points from Ejaz Ghani’s presentation:

• Foreign capital inflows—remittances, international syndicated bank lending, private capital investments, and bond issues—to South Asia had surged in recent years, but collapsed in the aftermath of the crisis.

• South Asia, even with lower capital flows, will suffer less compared to other regions because of its particular features because (i) South Asia’s investments are largely driven by domestic savings, (ii) South Asia is unique in attracting capital flows that are less volatile. The region relies more on remittances inflows than for example portfolio flows and bank loans.

• Given the high domestic savings and less dependence on volatile capital inflows, South Asia is likely to bounce back faster.

• (This is probably the most most surprising one for South Asia) Given that the current crisis is synchronized and global in nature, there is less room for an export led recovery.

• South Asia’s economy is largely service driven.Service exports are less volatile compared to goods exports. Globalization of services is still at an early stage.

• A service-led export growth strategy will likely enable South Asia to recover quicker and sustain high growth over the medium term. But not all countries will benefit as there is tremendous diversity within South Asia. (Nepal is clearly the nation which will not see the light of service sector-led growth as this sector is yet to emerge!)

• South Asia is the largest net importer of commodities (food, metal, and oil) in relation to GDP. The sharp decline in commodity prices, especially oil could reduce large commodity-related subsidies. Such savings could be used to finance discretionary fiscal stimulus.

• Recovery will depend on the composition of capital flows, trade, and economic management.

(Usually, when ‘South Asia’ is studied, researchers look at India, Sri Lanka, Maldives, Pakistan and Bangladesh only. They forget about Nepal, Bhutan, and Afghanistan). So, the conclusions and recommendations of these kind of study might not necessarily apply to the neglected economies. Btw, these are also the most poorest ones in the world.)

Diarrhea and death in Nepal

After a field visit to Jajarkot, a diarrhea affected rural village in Nepal where more than 200 people have died in three months, doctors from Nepal Medical Association write:

Dali. A women fell ill due to diarrhoea in a village six hours' walk from the Dali health post. Her daughter, who was working in the field, came back home due to diarrhoea and found that the mother was sick. None of the villagers helped to take her and her mother to the health facility. The mother died. The villagers locked the daughter in a dark room with husk and covered her with a blanket and took the mother to the river to perform the last rites, a two-hour walk from the village. Across the river lies Rari, Rukum where a health camp has been set up to tackle the epidemic. After the mother had been cremated, policemen saw the villagers putting out the fire. They asked them why they were putting out the fire. The villagers answered that they were saving wood as another person was ready to be cremated in the village. Luckily, the police rushed to the village and found the daughter in the dark room barely breathing and rescued her. While running to the health camp, the policemen said that the girl's blanket was drenched in stool which was falling in drops. The girl received treatment and survived.

Dhime. The team in Dhime heard that Gyanendra Sharma, a leper who had been previously kept at the District Hospital at Khalanga for one year to treat his rotting foot four years ago, was suffering from diarrhoea. On reaching the house to rescue the old man, volunteers saw no one in the house. They found the old man in a dark room, naked and covered in faeces. They asked the family to clean him up so that they could rescue him; the family refused and he died.

Seriously, where is all the aid money on health services going? Also, where are all those NGOs and INGOs at this time of crisis? Importantly, what the hell was the government doing in all these years? It is pity that in this century, people die of diarrhea at the rate of 100 per month. Its not because they don’t have clean water but because they are not educated well enough to use clean water, practice proper sanitation measures, and dispel some untrue, self-perpetuating health-related fears.

Market players screwing up prices in the Nepalese market

At a time when price level in the Indian economy is in downslide, the opposite is going on in Nepal. This is pretty uncommon because the Nepalese market follows price trend of the Indian economy. Unfortunately, price level  in the Nepalese market is over 13 percent right now. Something fishy is going on in Nepalese food and commodity market. Who is to blame? Well, the speculators and retailers who are holding back inventories, thus creating an artificial rise in price level! The government is clamping down on these by directly intervening in the supply side of the market. Some times the market forces is detrimental if left to operate wildly and unchecked! So, the government has to tighten loose screws so that it operates as it should!

Studies by the government and other entities show that price rise is caused primarily by hoarding and black-marketeering (30%), stockists and wholesalers (20%), bandhs and strikes (10%) and the Indian market (40%).

District Administration Office raided 13 godowns of three businessmen on Saturday under Black Marketeering and Certain Other Social Offences Act, 1978. Meanwhile, the Department of Commerce got active in implementation of the price-list (wholesale and retail) in retail shops of Kathmandu.

According to Kailash Kumar Bajimaya, acting director general at DoC, “hoarding is storage of large quantity of food commodities and failure to send them back to the consumer market to make profit, creating artificial scarcity of the items.” Warehousing of the food commoditiesby agents, dealers and retailers exceeding one month without any transaction is punishable by existing law. Bajimaya said the raid conducted by the DAO was targetted at the black marketeers and DoC’s price-list campaign is to educate the consumers. He said market intervention would continue until the consumers got respite from the unethical trade practices.

The commodities market has around 25 players — at least 20 business organisations and traders, including KL Dugar, Pawan Bansal, Chandreshwor Prasad Kalwar, Pawan Kumar Agrawal and Murarka Group.

“We have asked their import/purchase papers, customs papers, VAT papers and general account,” said Surendra Prasad Paudel, administrative officer. According to Paudel, the businessmen have to show their papers and prove their innocence within a week.

Social programs and inequality in Brazil

Brazil has made improvements in reducing inequality despite growing at a good rate in recent years. Inequality, measured by the Gini coefficient, fell from 0.59 in 2001 to 0.53 in 2007. How is it possible that inequality fell despite high economic growth? The authors of this one pager#89 from IPC argue that it is because of good social policies, mainly two possible causes:

1. Improvements in education (universal admission to primary schooling and lower repetition rates). The authors estimate that the impact of improved access to education on primary income distribution was 0.2 Gini points per year from 1995 onwards.
2. Direct cash transfers from the state to families and individuals. An often cited example is a conditional cash transfer program called Bosla Familia. The authors estimate that cash transfers contributed to reductions in inequality of another 0.2 Gini points per year.

These social programs have stimulated aggregate demand, especially through an increase in consumption.

The main point is that two-thirds of the decline in inequality is explained by relatively successful social policies. The remaining third is attributed to “a virtuous cycle of increased income, expansion in domestic market and rising demand for labor.”

Few details about the remittances market in Nepal

Recently World Bank researchers presented their analysis on the remittances market in Nepal. The presentations and a policy note are very informative. This blog post draws in information from their analysis.

Around two to five million Nepalese workers are working abroad. Officially recorded new migration increased dramatically during the last decade, from 36,000 in 1999/2000 to 229,000 in 2007/08. Unofficial estimates of stock of Nepali migrants range from 400,000 in Malaysia, 300,000 in Qatar, 60,000-70,000 in South Korea, and 2 to 5 million in India. 125,000-275,000 Nepali migrants are estimated to be working in United Arab Emirates (UAE), of which half are in construction, hospitality, tourism, and security. An estimated one-third of male population are working abroad.

It constituted 17 percent of GDP in 2008 ($2.3 billion). Remittances also have large multiplier effects on sectors such as construction, cement and furniture. Migration played a crucial role in reducing poverty between 1994 and 2004. The WB estimates it to contribute between one-fifth to one-half of the decline in poverty. Within South Asia, remittances as a share of GDP is highest in Nepal.

Remittances sent by Nepali migrants from India, which is the largest migration destination, are larger than the bilateral trade deficit with India and underpin the exchange rate peg with the Indian rupee. Remittances have helped finance the trade deficit and maintain a positive current account balance over the last decade.

The onset of the financial crisis in the second half of 2008 has led to a significant decline in construction, hospitality and other sectors in the Gulf countries in which a large number of South Asian migrants are employed. As a result, the growth of remittances to Nepal has decelerated significantly in recent months and remittances flows are expected to decline modestly in 2009.

The decline in remittances (WB researchers estimate remittances would decline by a two-and-a-half percent to four percent in 2008/09 in Nepal) due to global economic slowdown will depend on projected economic growth rates of destination countries, the kind of work Nepalese migrants do and demand for such work in destination economies, and how secure their jobs are through contracts. The growth rate in Gulf countries is expected to slowdown but the good news is that remittances flows out of GCC are not correlated with oil prices. As long as infrastructure investment continues, drawing in from their large reserves, demand for migrant, cheap labor is going to increase or at least not decline. It is reported that some Gulf countries are replacing Bangladeshi workers with Nepali workers for “various reasons”. Furthermore, new countries like Libya, Romania, and Poland have agreed to take in Nepali workers. This means that demand for Nepali labor in the international market is not going to decline drastically despite the global economic slowdown.

Nepal’s remittance market is competitive and the remittance infrastructure is well-developed, with money transfer operators and banks able to deliver remittances reliably even in remote areas. But there are market inefficiencies in destination countries that ought to be addressed by policy makers. Bilateral negotiations with the authorities in destination countries can improve access of migrants to remittance services. Within Nepal, there should be efforts to encourage banks and finance companies to link remittances to consumer loans, housing loans, and small business investments. Post offices in destination countries and Nepal can play an important role in providing cheap and convenient remittance services. Mobile phone companies can also provide fast, convenient and cheap remittance services within Nepal.

The destinations of migration will likely change over time. It has nearly saturated in East Asia.The destinations that will increase in importance are the Gulf and India since these countries will grow and will need new workers. The Gulf countries have abundant financial resources to continue the construction and tourism projects (hotels, resorts, and restaurants) and investments in infrastructure which have been temporarily suspended since the onset of the current crisis. For example, Abu Dhabi, one of the seven United Arab Emirates, is building Khalifa City, which will need 150,000 new workers from abroad. India has also been relatively less affected by the current crisis and will remain an important destination, especially for seasonal migration, and also a source of migrants. In the long-term, Poland and Romania and other new members of the EU and possibly Russia are also likely to need migrant workers from Nepal.

According to data reported by Nepal’s central bank in a recent survey, 20 private commercial banks, 3 state-owned banks, 12 micro-finance institutions, the postal service, 4 other financial institutions and 36 non-financial institutions (such as Western Union, Moneygram, Prabhu, International Money Exchange etc.) are authorized to receive and deliver remittances. These commercial and state-owned banks have together 574 branches in the country, while MFIs have over 320 branches, the post office has 75 district offices and the non-financial money transfer operators have over 2,500 branches.

Commercial banks, money transfer companies and the post office are allowed to receive inward remittances. Microfinance institutions cannot send or receive remittances, but are only allowed to distribute remittances, acting as sub-agents of the firms authorized to receive inward remittances. No mobile phone operator in Nepal is authorized to send or receive remittances.

Nepalese banks typically act as distributors of remittances for partner money transfer companies. Unlike the major banks in India, very few Nepali banks promote other financial products such as savings deposits, home loans, health and life insurance to remittance senders or recipients. This may reflect relatively low banking penetration, the prevailing high levels of inflation and the uncertain macroeconomic environment, which might make Nepali banks unwilling to extend credit to retail borrowers in general, including to non-resident Nepalese.

Bringing remittances into formal (banking) channels and mobilizing remittances for savings and investment remain key challenges for Nepal. There are only 1.8 branches per 100,000 people in Nepal in 2006, compared to 4.7 in India, while ATM access is 0.28 per 100,000 people. More than 70 percent of people do not access to commercial banks. More than two-third of recipients in rural areas received international remittances (including from India) through informal channels such as hand-carry or through friends and relatives, compared to 34 percent of recipients in urban areas.

Increasing remittances have been driving real wages in the country. Agricultural wages rose 25 percent in real terms and nonagricultural unskilled wages increased by 20 percent. Meanwhile, skilled wages tripled, out-migration reduced labor supply and aggregate demand increased. With increasing remittances, income has grown and so has inequality-- a potential research area because it is not clear yet if increase in consumption fuelled by consumption (not domestically earned income) has actually increased inequality. Some argue that due to higher aggregate demand of remittance-receiving households, remittances can be linked to inequality.

The consequences of reduced remittances in Nepal are:

• Some people could fall back into poverty again. If the decline in remittances is between two to four percent, it would cost between $50-100 million to mange the additional people that fall below the poverty line.
• Reduced foreign exchange flows, leading to decline in consumption and imports. A small impact on BOP situation.
• Potential soft landing of real estate bubble as investment in real property would decline.
• Banks that are taking excessive risks in real estate market and margin lending may be strained.
• Departures would decline, putting tremendous pressure on the already stagnant domestic job market. It could fuel social tension. Note that approximately 500,000 people enter labor force each year at a time when the public and private sector are not hiring in the same rate.

What could the government do to mitigate the impact of declining remittances in the country?

• Create business environment conducive to private investment (it is the most popular recommendation but hardly realized!)
• Accelerate existing public investment and maintenance work that are labor intensive (question mark on effective implementation-- if it were possible, then with those millions of aid dollars, something substantial would have already been achieved in this sector!)
• Increase labor-intensive public and maintenance work (this sector has never been capital-intensive-- otherwise the state of Nepal’s infrastructure would not have been so dismal!)
• Start fiscally sustainable, high priority public work programs for the vulnerable (big problem in identification and demand for such work in places where vulnerable people live!)
• The banking sector might feel a pinch, leaving the central bank to encourage consolidation of an over-crowded sector (good if competitiveness and efficiency of the banking sector is further improved!)